Risk/return is back - Natixis
Research Team at Natixis notes that the risky assets were the best performers in 2016 with commodities in the lead and while equities and high yield posted double-digit returns.
Key Quotes
“The start of the year was one of the worst in history (-10% for the MSCI World over the first 10 days of 2016) against a backdrop of 1/ fears of a hard landing for the Chinese economy and a depreciation of the yuan and 2/ risk of a US recession with the oil price falling below $30 per barrel paralysing the US energy sector and the high yield sector.”
“It was precisely the rebound in the oil price - a real market gauge in the first half of the year - caused by the prospect of an oil production freeze agreement in mid-February in Doha (an agreement that failed) that lifted the mood. It triggered a virtually across-the board rebound in risky assets until the autumn and a fierce resumption of the search for yield especially in emerging markets. This was reflected by our proprietary risk perception index (RPI) which fell from above 90% in end-February to less than 10% in early October i.e. its lowest level in a long time (July 2014) and after two years of around 60% on average.”
“2016 was marked by two major shocks: the vote in favour of Brexit on 23 June and the election of Donald Trump as the 45th President of the United States on 8 November. The other significant - but more expected - electoral factor was the “no” at the Italian referendum on 4 December which once again made political risk the major theme for the coming year. The markets’ reaction was surprisingly serene thanks in particular to macroeconomic indicators that positively surprised the consensus in the second half of the year.”
“The underlying trend that really influenced the markets in 2016 was the shift from fears of deflation and recession at the start of the year to fears of renewed inflation. This was explained by the rebound in commodity prices but also by the solid upswing in wages and the prospect of fiscal stimulus in the United States. As a result interest rates started an upward trend from October in all geographical areas factoring in less accommodative monetary policies also. In the end this was not offset by political uncertainty (US. Italy).”
“The election of Donald Trump was even an accelerator of this development with 1/ a massive bond repricing taking into account inflationary trends and a Reagan-style change of policy mix; 2/ a rebound in US equities with small caps in the lead due to expectations of upcoming favourable measures for US companies (tax cuts in particular) and 3/ a marked rebound in the US dollar. In this rotation move the correlation between equity and bond returns has remained negative but volatile overall with more jumps at the end of the year.”
“All in all, the best bets in 2016 were those based on:
- Long emerging countries - until the election of Trump. The signs of a macroeconomic recovery and the decrease in Chinese risk in the short term attracted non-resident investments seeking return. The election of Trump and the fears of associated protectionist measures accounted for a partial withdrawal (around two-thirds) of these inflows.
- Long oil, industrial metals (and breakeven inflation). due to the upswing in demand (for metals. we note above all stimulus through infrastructure and construction in China) in a context where growth in supply is slowing down (disinvestment over the last few years. freeze on production).
- Carry and search for yield: the stability of the macroeconomic environment was positive for carry strategies and search for yield: high-yield sector emerging debt (e.g. the massive success of the two largest bond issues in the history of emerging countries in April by Argentina with $16.5bn. and in October by Saudi Arabia with $17.5bn) and FX carry.
- UK assets (currency hedged). The "flight to quality" aspect benefited Gilts in the post-Brexit period and before the appearance of fears about imported.”